Developers in residential property can potentially add value to their properties, for example by constructing a second storey or garage or by renovating the kitchen or bathroom. On the other hand, with commercial properties these opportunities are relatively limited even in prime locations, where the established street frontages and local government regulations can prohibit large-scale renovation works. On the positive side, the owner of commercial property can improve the returns and capital value of their building by undertaking a cosmetic makeover to improve the look of building or by changing the lease to offer more favourable terms.
Although rental growth will vary according to location, commercial property offers greater opportunities for growth when compared with residential. Rental yields, which are based on supply and demand for accommodation, are generally lower in residential properties than in commercial. Annual rental increases on commercial leases are generally in line with the consumer price index (CPI) or 4 per cent, whichever is the greater. This is not always achievable with residential property. Commercial property leases tend to be much longer as well – from three to twenty years – and are quite often secured by bank guarantees, which make them a secure investment.
Depending on its location, a residential development can cater for a broader market than a commercial property. It is also easier to market and sell a residential development, such as an apartment block, as it can be broken down into smaller units that can be divided into strata sections and sold to a number of purchasers. A commercial building with similar floor area, such as small office block or shopping centre, would look to a single purchaser.
Based on the scale of the development, most residential projects require a smaller amount of capital to get started. In addition, lending institutions have the infrastructure and systems to make it easier for the consumer to apply for a home loan. With more banks and new mortgage companies entering the market, finance for a home is a lot easier to secure than for a commercial development. As commercial developments require larger capital, the application for funding is more complex and takes longer to gain approval.
With residential finance more readily available for end-purchasers, housing developments are a lot easier to sell than commercial developments. This allows residential developers to exit their development earlier. In addition, there are generally not as many conditions attached to the purchase of a residential property, making settlement and the sales procedure a lot quicker. With commercial developments, finding an end-buyer can be complicated as these buyers, being more sophisticated, will impose more stringent conditions. A commercial project will also generally take longer to construct, thereby incurring more interest.
Purchasers of residential property are not as sophisticated as seasoned investors interested in commercial properties. Commercial property investors will generally negotiate strongly on a number of issues thereby delaying the settlement, which in turns affects the developer's profit. A residential property generally is sold based on a standard offer and acceptance executed by a real estate agent, whereas for larger commercial properties a solicitor is required to formalise the purchase.
During the boom period of a property cycle, residential properties have a far greater capital growth than commercial. A shortage of residential properties on the market will drive prices up, whereas the value of commercial properties is tied to the term of a lease with only a CPI-related increase in value. However, most commercial properties have a rent review over an agreed period to make up the loss of capital growth during the boom period.
Commercial properties can be harder to lease owing to the specific requirements of commercial tenants. In some instances, owners who are pressed to find a commercial tenant will offer generous lease terms to make sure the property is not vacant. These terms can take the form of rent-free periods or heavy expenditure to meet the tenant's specific needs. They could also delay a project as a certain percentage of leases could be a precondition for construction finance. With residential, the developer has the flexibility to sell part of the development to individual purchasers and rent out the balance – if, of course, the residential developer has selected to develop in a location where there is good infrastructure.
From the foregoing assessment it may seem that commercial properties involve greater risks. In general this is true, but for the knowledgeable and experienced there are greater profits to be made for the same investment of time and personal engagement in the commercial sector than in residential developments. Remember, the higher the risk the more profitable the investment.
Types of residential developments
Residential developments can be categorised into the following areas.
Some older suburbs in capital cities offer exceptional opportunities for renovating older homes and the developer can be rewarded with good returns within a short period. These renovations may require structural alterations or additional rooms or involve no more than adding some paint to bring the building to present market standards.
The speculative new home is usually built on a single lot in a new land subdivision or on an older block that has been subdivided to create smaller lots, as normally found in older suburbs. Developers can also market ‘house and land' packages, subdividing the land into smaller lots and then selling two contracts, one for the land and the other with a selected building contractor.
These smaller unit developments of two to six single- or double-storey units are commonly found in suburban areas of both new and old subdivisions and may be defined as villas or townhouses. They can be developed as strata-type units or small green title lots. This scale of development is ideal for the novice developer as they sit in the lower risk category, subject to the developer selecting the right location and undertaking a comprehensive market research and analysis.
Under this category one would find a group of eight or more units, which can include townhouses, villas or retirement villages. Each development will have its own architectural theme defined by similar use of materials, scale and building style. Larger projects of 20 or more units are best built in phases in order to mitigate risk and improve cash flow.
These buildings are found mainly in the inner-city areas of capital cities. They are defined as dwellings in a group of more than one where any part of a dwelling is built vertically above part of any other. As urban populations grow and infrastructure costs in sprawling cities increase, suburbs close to the central business districts (CBD) with good services and transport systems are allowing increasing densities, which encourages apartment developments.
Also known as public or social housing, these developments are provided by the government for members of the community who cannot afford either to purchase their own home or to cover the higher rents demanded in the marketplace. Given their own limited resources, governments cannot provide all the social housing required and will enter into joint ventures with developers or provide tax incentives to developers in providing such housing.
These developments can vary in scale from small backyard subdivisions to larger scale suburban community land developments. The latter require intensive town planning in conjunction with the local council's planning department and various other government authorities. While these developments carry less construction risk, the developer will require enough cash to endure the lengthy and protracted approval process.
In addition to the foregoing residential developments, we can consider a number of developments as niche markets. These include:
• holiday homes
• timeshare apartments
• cooperative housing
• student accommodation
• lifestyle villages
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